Financial illiteracy blamed for growing govt tax take

The UK government has been able to collect more taxes than anticipated through the pension freedoms due to a lack of knowledge from savers about pension withdrawals, the Organisation for Economic Co-operation and Development (OECD) has said.

In the UK, individuals "may not understand the consequences in terms of taxes paid of withdrawing funds from their pension account," it stated.

Since the introduction of pension freedoms in 2015, savers with defined contribution pensions have the option to withdraw their funds from age 55 subject to tax paid at their marginal rate, rather than the 55 per cent charge previously in place.

"The reform allowed the Treasury to collect far more taxes than anticipated," the OECD noted.

The government had initially estimated to raise about £0.3bn in 2015/16 and £0.6bn in 2016/17, but it has actually raised far more than anticipated, the body stated.

In fact, the Treasury had raised £1.5bn in 2015/16, while the latest estimate for 2016/17 was £1.1bn.

When legislating on retirement, countries "have to consider protection from longevity risk, flexibility and choice when designing the post-retirement phase," the OECD stated.

The body suggested an appropriate default post-retirement product should include a combination of programmed withdrawals, offering flexibility during the first years in retirement, with a deferred life annuity for the later years.

The proposal, announced in June, is aimed at making retirees do the best they can with their pension pots, including nudging them earlier to make a decision about their nest egg, and making pension companies clarify charges in pounds and pence not percentages.

But the OECD also warned that traditional rules of thumb to drawdown pension assets in programmed withdrawals "may not provide optimal outcomes".

The body pointed to three options normally adopted by savers: to leave the money in the retirement accounts untouched and spend only the investment income; to divide all financial assets by the remaining life expectancy each year, as predicted by life tables; or the 4-percent rule used by some financial advisers, under which the retiree each year withdraws 4 per cent of the initial amount of assets accumulated at retirement.

However, this "strategy lacks flexibility, as the withdrawn amounts do not adjust to the performance of the portfolio," it noted.

FTAdviserreported in May that advisers have warned against a "one size fits all" approach towards calculating drawdown rates.

According to an expert study from the Center for Retirement Research at Boston College, all three strategies underperform the optimal drawdown pattern, with the life expectancy strategy being the closest and the 4-percent rule being the farthest from the optimal.

Alan Chan, director of chartered financial planners IFS Wealth & Pensions, agrees that financial illiteracy was probably to blame, as people are struggling to understand pensions.